Fiscal Policy - Explaining Automatic Stabilisers

This revision video covers the important role of automatic fiscal stabilisers.

In questions about fiscal policy, your analysis is strengthened by making a distinction between discretionary fiscal policy such as the furlough scheme and automatic stabilisers which kick-in when the economy moves into a slowdown or recession. Both can have important effects.

What are fiscal automatic stabilisers?

Automatic stabilisers are automatic fiscal changes as the economy moves through different stages of the business cycle – such as a fall in tax revenues from the circular flow during a recession or an increase in state welfare benefits when the unemployment rate is rising.

Automatic stabilisers during strong economic growth

• During periods of rapid economic growth (a boom phase)
• Tax revenues will rise as household real incomes and corporate profits grow – unemployment is declining
• Government welfare spending then falls as more people are in work and require less state financial support
• As a result, government finances improve including a falling budget deficit / possible fiscal surplus
• Consequently, fiscal policy is taking income out of the circular flow – automatic stabilisers help moderate a boom

Automatic stabilisers during an economic recession

• During an economic recession, real output and employment contracts
• As real incomes fall, people pay less in direct and indirect taxes and company tax payments also drop
• And government spending on welfare support such as Universal Credit increases
• Combined, this will increase the budget deficit
• A fiscal deficit is a net injection into the circular flow – thus helping to limit the depth / severity of a recession

Evaluation: How effective are automatic stabilisers in the UK economy?

1. Impact depends on whether a government allows the automatic stabilisers to operate fully – and does not introduce fiscal austerity measures such as real spending cuts during a slowdown / recession
2. Impact depends on the relative generosity of the welfare system such as base levels of payment for universal credit and unemployment support. Some governments have capped total welfare payments.
3. Impact depends on the marginal propensity to spend and save of those households whose income is boosted by welfare during a recession